I have maintained for many years that one
important goal of risk management is to seek and maintain a rational balance
between excessive risk-taking and excessive risk aversion. “Betting the
farm” is akin to plowing your entire savings into lottery tickets. You
might win, bringing instant wealth, but the odds in favor of
losing your investment are inordinately high. Similarly, eschewing risk
at all costs will almost always lead to disappointment as your organization
withers and dies from lack of innovation. Selfevident, you say, but how
do today’s organizations measure up on their “risk balance?”
Three authors give contradictory opinions, the first two in a recent
article in Harvard Business Review and the third in a book from
England. Both cases are persuasive and worth reading.
The Nobel-laureate Daniel Kahnemann, from Princeton University, and Dan
Lavallo, a senior lecturer at the University of New South Wales, argue
in “Delusions of Success” that “in planning major initiatives, executives
routinely exaggerate the benefits and discount the costs, setting themselves
up for failure.” The authors suggest this is attributable to the latent
optimism that resides in all of us. A new project proposal inevitably
comes with enthusiastic sponsors who over-estimate its positive attributes.
Similarly, these sponsors tend to “neglect the potential abilities and
actions” of competitors. They assume that rivals will fail to respond
or move too late. And finally, when an organization has limited funds
for new projects, those selected for investment will be the ones carrying
“the most over-optimistic forecasts.”
Kahnemann and Lovallo believe that “optimism generates much more enthusiasm
than it does realism (not to mention pessimism).” Is this a new and recent
phenomenon or has it always been so? I suggest this been a continuing
characteristic of our human species. The authors then suggest five steps
to correct the optimistic bias they say is found today in many organizations:
Select a “reference class” of outside data or organizations with
which to compare the proposed project, and rank your idea against
Assess the distribution of outcomes of these projects/data, taking
care to consider carefully the extremes.
Make an intuitive prediction of your project’s position in the distribution.
Assess the reliability of your prediction.
Correct your intuitive estimate.
Sounds very much like traditional risk management thinking, doesn’t
it? Kahnemann and Lovallo conclude that most managers are “likely to underestimate
the overall probability of unfavorable outcomes.”
The contrary opinion comes from Benjamin Hunt, a UK journalist. “Business
is terrified of taking risk,” he writes. In The Timid Corporation,
published by John Wiley & Sons Ltd. earlier this year, Hunt argues that
today’s corporations are enveloped in a cloud of “irrational pessimism,”
and that “risk aversion has become more of a permanent mindset and mode
of operation, independent of the business cycle.” He sees risk aversion
“institutionalized in business.” Part of the blame lies with risk management
itself: “the problem with the enormous rise of risk management is that
it entrenches a new intolerance of risk and uncertainty.” On the surface,
Hunt is at odds with Kahnemann and Lovallo.
The Timid Corporation is meticulously researched but, with a
seven page bibliography full pages of books and articles. Unfortunately,
most of them come from the insurance and finance arenas. Hunt did not
tap any of the vast resource of public policy risk management documentation.
It might not have changed his gloomy prognosis but it would have enriched
Hunt begins his first section by castigating the “re-regulation of the
corporation,” a process that entrenches caution through both external
and self-regulation. He tackles briefly the problems of the risk management
discipline and then suggests that managing for shareholder value creates
a new form of financial risk aversion. His second section suggests that
industry has adopted a “defensive mode” and that it is obsessed with the
customer. Through an emphasis on brands and customer loyalty, it has “dumbed
down innovation.” All this leads to a “fear of growth.” Finally, Hunt
describes the current “crisis of self-belief” and sets forth suggestions
for breaking the current paralysis.
I can’t accept his entire thesis but pieces
ring true. For example, Hunt writes: “Rather than take a lead in upholding
strong principles and shaping change, corporations attempt to ‘listen
to society’ and ‘listen to the customer’. But the world around them—including
the business world and broader society—has also become more risk-averse
at the same time, and newly demands caution and restraint in behaviour.”
This is a valid point: corporations are a part of the culture and it is
undeniably more cautious today than a decade ago. After the shocks of
the breaking bubble and the advent of global terrorism, a fresh emphasis
on regulation is understandable. But Hunt says that the “holy trinity
of accountability, responsibility and transparency” has moved too far.
The precautionary principle in public affairs has been adopted by business:
“do not experiment unless the outcome is safe and poses no risks.” He
equally criticizes self-regulation, with the rise of interest in ethics
and corporate governance. I agree with him when he writes: “just repeating
the term corporate governance more than a few times in one day can make
lips seize up with dryness!”
Then Hunt argues that listening to society can be irrational, citing
the example of the Brent Spar fiasco. True, but that case and others similar
to it do not mean that it is improper to engage other stakeholders in
serious discussions about risk. I believe that it is worthwhile, over
time, to reach out to the public and especially to NGOs, even when they
The author’s dissection of risk management is both savage and incomplete.
Yes, too many insurance and financial risk managers are paranoid about
uncertainty and come on as the resident corporate naysayers. True, managers
can be easily frustrated when “highly tedious, door-stopper-like risk
management manuals land with a thump on their desk(s), and they are asked
to wade through them before making a decision.” But most of today’s risk
management practitioners can entwine logical and reasonable risk analyses
within their organizations without recourse to monumental tomes. Hunt’s
history of risk management is flawed as it is almost entirely related
to its development within insurance. His notes indicate that he interviewed
14 “risk managers,” but, from the tone of this chapter, most of them must
have been insurance risk managers, leaving our credit, market, public
policy and other operational risk practitioners. He cites no names or
titles, so I cannot be sure. Hunt also perpetuates the discarded and thoroughly
discredited distinction between “passive” and “speculative” risks, a construction
of the insurance industry to avoid taking on risk with which it was unfamiliar.
Most observers today accept that risk involves both upside and downside
potentials and that trying to separate them into distinct packages is
a disservice to the idea of treating risk holistically.
Hunt’s attack on the “new obsession with the customer” goes too far.
When Ralph Nader wrote Unsafe at Any Speed in the 1960s, the
prevailing legal dictum was caveat emptor – let the buyer beware.
Nader argued successfully that much more was required of the selling corporation
and the consumer movement began. Today, largely as a result of Nader’s
continuing work, the current dictum is caveat vendor – let the
Perhaps the pendulum has swung too far, especially with litigation in
the US, but it has redressed a prior imbalance. Hunt’s argument that today’s
corporation is fixated on customer loyalty and brand protection may be
true but I’m not ready to accept the conclusion of his syllogism that
this leads to the stagnation of innovation and a fear of growth. I do
agree with his identification of a major current irony: “just at a time
when managers and corporations see the world as more risky and unpredictable
and are more defensive, a range of commentators view corporations as wanting
aggressively to ‘take over’ the world.”
Hunt argues that a social climate of risk aversion affects corporations
but does this instill excessive caution in all of them? I admit
to being more of an optimist: it’s only a temporary mood. I do agree with
his two suggestions for change: take a more critical attitude toward regulation
and self-regulation, and raise expectations of technological progress.
The latter will occur and will shift us out of our malaise! Finally,
Hunt is right when he writes that “in this world, it is worth bearing
in mind that a society that does not try to shape its future ends up by
being dictated to by its anxieties.
So we have two views of our current situation. One says that organizations
are too risk avaricious, the other that we are too risk averse. Take your
The ideal is to draw a clear distinction between those functions
and positions that involve or support decision-making and those
that promote or guide action. The former should be imbued with
a realistic outlook, while the latter will often benefit from
a sense of optimism.
Dan Lovallo and Daniel Kahnemann, “Delusions of Success,”
Harvard Business Review, July 2003